What Features of Zimbabwes Economy Provides a View of the Cost of Hyperinflation - Assignment Example

Name: Course: Institution: Tutor: Question 1: Describe the money growth rate and the inflation rate in Zimbabwe since 2000. How do we know that Zimbabwe’s reported inflation between 2003 and 2007 is almost certainly below the true inflation rate? Inflation is the percentage change in price index while money growth is the percentage change in money supply. The following table and graph show the respective levels of inflation and money growth in Zimbabwe between 1998 and 2007. Year GDP Growth (%) Inflation Change Money Growth Change 1998 -0.8 47 26 1999 -2.1 57 39 2000 -7 55 53 2001 -3 112 144 2002 -4 199 171 2003 -10 599 491 2004 -2 133 234 2005 -4 586 547 2006 -3 1281 1315 2007 -6 7982 66659 Table 1: Macroeconomic Trends in Zimbabwe 1998 – 2007 (AFP, 2008) As shown in the table above, Zimbabwe’s inflation increased from around 47% in 2000 to 7982% in a span of just 10 years. Thereafter, the inflation kept increasing to reach 231,150,889 % in 2008 when the country disbanded the national currency and adopted various foreign currencies as legal tenders (Doug et al, 2010). Since the year 2000, Zimbabwe experienced annual inflation rates of more than 100%. In 2006, the country’s inflation rate rose to more than 1500% annually. Currently, Zimbabwe is the only country with a hyper inflated economy and is the worst case of inflation to be recorded in the 21st century. Zimbabwe’s money growth rate was less than 50% in 2000 (AFP, 2008). In 2001, the growth rate of money showed a higher rate of increase than the inflation rate and maintained a steady growth in inflation in the subsequent years before reaching 66700 in 2007. The country’s inflation and money growth paths stated to diverge in late 2003 (Doug et al, 2010). Annual inflation soared from les than 47% in 1998 to a peak of 625% at the beginning of 2004 but decelerated in March 2004. In contrast, broad money growth started to decelerate in July 2004 from 400% in December 2003 to 130% in July 2004 (AFP, 2008). This was in contrast to the experience under stabilization efforts in majority of countries where inflationary inertia has been witnessed. Inflationary inertia means that inflation lags instead of leading to the decline in money growth because wage and price expectations are likely to be based on the past behavior of inflation. The negative changes in Zimbabwe’s monetary expansion could not translate into positive changes in the rate of inflation (AFP, 2008). Further, the government’s monetary tightening programs could not be perceived as credible since they did not bring any stabilization effect on the diverging trends in money growth and inflation rates. It, thus, seems that prices in Zimbabwe’s appear to have responded to factors different from change in monetary policies. To a large extent, Zimbabwe’s extra ordinary inflation was fuelled by huge money expansion as well as fall in industrial production and depreciation of exchange rates. The increasing decline in velocity as well as increasing levels of real money in 2004 and 2005 was at odds with the record of inflation tracking growth of monetary incentives in the previous years (AFP, 2008). Possible explanations for the divergence of money growth and inflation rates include unstable demand for money and rapid shifts and for real balances. Despite the official figures for Zimbabwe’s inflation rate, there are chances that the real rate of inflation was different and possibly much higher than the reported inflation rate. A number of factors attest to this fact. First, the Central Bank of Zimbabwe printed trillions of Zimbabwean dollars to purchase US dollars and other currencies, which could later replace the Zimbabwean currency. This was the case despite the government’s assurance that it could take reasonable measures to contain the rising inflation and stabilize the value of the country’s currency. Secondly, the government, as from 2009, stopped issuing official statistics to show the country’s true rate of inflation. This was perceived by economists and analysis as an admission that the true rate of inflation was high and probably difficult to determine precisely (AFP, 2008). Another hint that shows that Zimbabwe’s true rate of inflation was different from that reported in official figures is the government’s decision to strike zeros off the country’s bank notes. The inability of the people to buy basic commodities such as medicines, fuel and food even after all these measures have been taken by the government is a clear indication that the true rate of inflation was quite higher than the reported rate. Question 2: What features of the Zimbabwe’s economy provides a view of the cost of hyperinflation? Zimbabwe’s hyper inflation has had deleterious effects on its economy. In particular, the Zimbabwean economy has shrunk since the year 2000 and this has resulted in a desperate situation for the people. Unemployment and poverty have increased considerably and most people can’t get access to basic commodities and services such food, medicines, water and fuel. Between 2005 and 2010, the high inflation in Zimbabwe forced the Central Bank to print and circulate denominations of up to 10 trillion Zimbabwean dollars (AFP, 2008). These denominations were, however, less significant in containing the ever increasing inflation rate and as a consequence, the Zimbabwe’s currency was suspended in favor of stable currencies such as the US dollar, British pound and South African rand. The government of Zimbabwe has plans to launch a new currency in the year 2012 (AFP, 2008). It is, however, not clear whether the new currency will be effective in returning Zimbabwe’s economy to its pre-2000 levels. The high level of inflation was evident of the rapid and massive increase in money that is not supported by corresponding growth in output of goods and services. The effect of this in Zimbabwe’s economy is the apparent imbalance between the supply and demand for money (both currency and bank deposits). This has been accompanied by total loss of confidence in the country’s monetary system similar to that of a bank run. The swift enactment of legal tender laws and price controls are some of the measures that have been taken by the government to control the high rate of inflation. These measures have however failed to reverse the deteriorating acceptance of paper money, which lacks intrinsic value (Sònia, 2006). Perhaps, the best indicator of Zimbabwe’s hyperinflation is its effect on the economic growth rate. Since the year 2000, Zimbabwe has had a negative economic growth rate. The negative growth rate has made it difficult for the economy to attract investments in key sectors of the economy. This has further worsened the economic crisis, leaving the economy at the brink of collapse (AFP, 2008). The other indicator is the rapid cropping up of the black market. The black market has developed mainly in response to the high demand for foreign currency, especially the United States dollar. As inflation grew at an exponential rate, there was urgent need to exchange Zimbabwean dollars as soon they were acquired. Besides foreign exchange transfer, the black market has helped serve the high demand for daily and essential products such as bread. Between 2007 and 2009, grocery stores in Zimbabwe were literary bare and the black market helped bride this gap. Question 3: What policy changes would address Zimbabwe’s inflation problem? Explain. The most effective policies for controlling inflation should be able to address the root cause of the problem and its impact on the economy (Sònia, 2006). For the case of Zimbabwe, a combination of monetary, fiscal and income policies can help address the high inflation rate and restore the economy to its pre-2000 state. In particular, the Central Bank of Zimbabwe should take measures to control interest rates with the aim of averting the impact of inflation. Such a monetary policy can help control growth in demand though increase in interest rates and contractions in the supply of real money. Among the most effective fiscal policies that the government can take to lower inflation rates, include reducing the amount borrowed by government sectors and reducing government spending. These policy measures can be effective in increasing the rate of leakages from circular flow and at the same time reducing injections into the circular flow of income. It is imperative for the government to institute direct wage control measures. This means that the government should set limits on the rate of growth of wages, as this initiative has the potential to decrease inflation rates (AFP, 2008). Although the wage restriction measure is rarely used, the Zimbabwean government can use it to influence wage increases by restricting salary increases in the public sector and by setting limit to cash pay for public sector employees. The government can also try moral suasion in the private sector to persuade employers and employees to moderate wage negotiations. It is also important for the Zimbabwean government to engage supply side policies in addressing the inflation problem. Supply side policies can be effective in improving an inflationary economy’s long term competitiveness and productivity. For instance, deregulation and privatization can help make firms more productive in the long run. Hence such measures can be important in reducing inflationary pressures on an economy. It is, however, important to note that supply side policies only work in the long run and hence cannot be used to reduce sudden increases in inflation rates (Sònia, 2006). The government can also take measures to control the high rate of inflation in the country stabilizing the exchange rate of its currency. A fixed exchange rate regime can help stabiles the value of the Zimbabwean currency against other currencies and hence there will be no need to use foreign currencies (AFP, 2008). For this reason, it is important for the government to stop further printing of notes as this adds to the excessive circulation of money, which keeps the inflation high. If the government decides to use foreign currencies, those currencies should be relatively stable over the long term since inflation rate is directly related to the stability of an economy. It is however more convenient for the country to continue with its old currency instead of introducing a new one or adopting foreign currencies (AFP, 2008). As such, the government should introduce the old Zimbabwean dollar and take appropriate policies to maintain its value by declaring a fixed exchange rate for the country’s currency against major world currencies. As a general measure, it is recommendable that the government to evaluate the fundamental blocks of its economy and address possible triggers of inflation and economic recession. Question 4: Will deleting ten zeros of fall prices stop Zimbabwe’s inflation problem? Explain. Deleting ten zeros off the prices of commodities will not have any effect on the country’s hyper-inflation (AFP, 2008). This is because prices are not subject to the value of the currency but prevailing market conditions and the state of the economy. For instance, if the demand of some commodities exceeds their supply, then the price of these commodities will surely rise until their supply equals demand. In this case, the rising price is a form of inflation can only be adjusted through demand-supply equilibrium and not through manipulation of the currency. Ideally, inflation rates change with changes in market prices of commodities, after which actual levels of inflation remain constant. In the case of Zimbabwe, this cannot be of any effect in containing the high inflation problem (Sònia, 2006). Instead of deleting zeros off the prices of commodities, the government of Zimbabwe can implement various fiscal and monetary policies. These policies would then be regulated through such measures as use stable currencies. The government should encourage and give incentives for increased levels of industrial production. The government can also take measures to attract foreign direct investments by liberalizing the economy and removing barriers to foreign investment (AFP, 2008). These measures will help stimulate production in the underperforming and non-performing sectors of the economy, which are the chief contributors and victims of inflation. Ideally, deleting some zeros from the prices of commodities will only be a mechanism for converting prices to cheaper denomination and hence facilitate transactions, but the effects of inflation will still remain. Reference AFP. (2008). Reading between the lines: Zimbabwe unveils 50million Dollar Note. 12 December, Agencies France Press. Doug, M., Christopher, F. & Michael, P. (2010). Economics. Sydney: Pearson Education Australia. Sònia, M. (2006). Washington: Suppressed Inflation and Money Demand in Zimbabwe, Issues 6-15. International Monetary Fund. Read More